This
article examines the funding of bank supervision in the context of the dual
banking system. Since 1863, commercial banks in the United States have been
able to choose to organize as national banks with a charter issued by the
Office of the Comptroller of the Currency (OCC) or as state banks with a
charter issued by a state government. The choice of charter determines which
agency will supervise the bank: the primary supervisor of nationally chartered
banks is the OCC, whereas state-chartered banks are supervised jointly by their
state chartering authority and either the Federal Deposit Insurance Corporation
(FDIC) or the Federal Reserve System (Federal Reserve).1 In their
supervisory capacity, the FDIC and the Federal Reserve generally alternate examinations
with the states.

The
choice of charter also determines a bank’s powers, capital requirements, and
lending limits. Over time, however, the powers of state-chartered and national
banks have generally converged, and the other differences between a state bank
charter and a national bank charter have diminished as well. Two of the
differences that remain are the lower supervisory costs enjoyed by state banks
and the preemption of certain state laws enjoyed by national banks. The
interplay between these two differences is the subject of this article.
Specifically, we examine how suggestions for altering the way banks pay for
supervision may have (unintended) consequences for the dual banking system.

For
banks of comparable asset size, operating with a national charter generally
entails a greater supervisory cost than operating with a state charter.
National banks pay a supervisory assessment to the OCC for their supervision.
Although state-chartered banks pay an assessment for supervision to their chartering
state, they are not charged for supervision by either the FDIC or the Federal
Reserve. A substantial portion of the cost of supervising state-chartered
banks is thus borne by the FDIC and the Federal Reserve. The FDIC derives its
funding from the deposit insurance funds, and the Federal Reserve is funded
through the interest earned on the Treasury securities that it purchases with
the reserves commercial banks are required to deposit with it. By contrast,
the OCC relies almost entirely on supervisory assessments for its funding.

The
current funding system is a matter of concern because—with fewer
characteristics distinguishing the national bank charter from a state bank
charter—chartering authorities increasingly compete for member banks on the
basis of supervisory costs and the ways in which those costs can be contained.
Furthermore, two recent trends in the banking industry have been fueling the
cost competition: increased consolidation and increased complexity.
Consolidation has greatly reduced the number of banks, thereby reducing the
funding available to the supervisory agencies, while the increased complexity
of a small number of very large banking organizations has put burdens on
examination staffs that may not be covered by assessments. Together, these
three factors—the importance of cost in the decision about which charter to
choose, the smaller number of banks, and the special burdens of examining
large, complex organizations—have put regulators under financial pressures that
may ultimately undermine the effectiveness of prudential supervision. Cost
competition between chartering authorities could affect the ability to
supervise insured institutions adequately and effectively and may ultimately
affect the viability of the dual banking system.

The
concern about the long-term viability of the dual banking system derives from
changes to the balance between banking powers and the costs of supervision. If
the balance should too strongly favor one charter over the other, one of the
charters might effectively disappear. Such a disappearance has already been
prefigured by events in the thrift industry.

The
next section contains a brief history of the dual banking system and charter
choice, explaining why the cost of supervision has become so important. Then
we examine the mechanisms currently in place for funding bank supervision, and
discuss the two structural changes in the banking industry that have fueled the
regulatory competition. Next we draw on the experiences of the thrift industry
to examine how changes in the balance between powers and the cost of
supervision can influence the choice of charter type. Alternative means for
funding bank supervision, and a concluding section, complete the article.

A Brief
History of the Dual Banking System and Charter Choice

Aside
from the short-lived exceptions of the First Bank of the United States and the
Second Bank of the United States, bank chartering was solely a function of the
states until 1863. Only in that year, with the passage of the National
Currency Act, was a federal role in the banking system permanently
established. The intent of the legislation was to assert federal control over
the monetary system by creating a uniform national currency and a system of
nationally chartered banks through which the federal government could conduct
its business.2 To charter and supervise the national banks, the act
created the Office of the Comptroller of the Currency (OCC). The act was
refined in 1864 with passage of the National Bank Act.

Once
the OCC was created, anyone who was interested in establishing a commercial
bank could choose either a federal or a state charter. The decision to choose
one or the other was relatively clear-cut: the charter type dictated the laws
under which the bank would operate and the agency that would act as the bank’s
supervisor. National banks were regulated under a system of federal laws that
set their capital, lending limits, and powers. Similarly, state-chartered
banks operated under state laws.

When
the Federal Reserve Act was passed in 1913, national banks were compelled to
become members of the Federal Reserve System; by contrast, state-chartered
banks could choose whether to join. Becoming a member bank, however, meant
becoming subject to both state and federal supervision. Accordingly,
relatively few state banks chose to join. The two systems remained largely
separate until passage of the Banking Act of 1933, which created the Federal Deposit
Insurance Corporation. Under the act national banks were required to obtain
deposit insurance; state banks could also obtain deposit insurance, and those
that did became subject to regulation by the FDIC.3 The vast
majority of banks obtained federal deposit insurance; thus, although banks
continued to have their choice of charter, neither of the charters would
relieve a bank of federal oversight.

As
noted above, over the years, the distinctions between the two systems greatly
diminished. During the 1980s, differences in reserve requirements, lending
limits, and capital requirements disappeared or narrowed. In 1980, the
Depository Institutions Deregulation and Monetary Control Act gave the benefits
of Federal Reserve membership to all commercial banks and made all subject to
the Federal Reserve’s reserve requirements. In 1982, the Garn–St Germain Act
raised national bank lending limits, allowing these banks to compete better
with state-chartered banks. Differences continued to erode in the remaining years
of the decade, as federal supervisors instituted uniform capital requirements
for banks.

As
these differences in their charters were diminishing, both the states and the
OCC attempted to find new ways to enhance the attractiveness of their respective
charters. The states have often permitted their banks to introduce new ideas
and innovations, with the result these institutions have been able to
experiment with relative ease. Many of the ideas thus introduced have been
subsequently adopted by national banks. In the early years of the dual banking
system, for example, state banks developed checkable deposits as an alternative
to bank notes. Starting in the late 1970s, a spate of innovations took root in
state-chartered banks: interest-bearing checking accounts, adjustable-rate
mortgages, home equity loans, and automatic teller machines were introduced by
state-chartered banks. During the 1980s the states took the lead in
deregulating the activities of the banking industry. Many states permitted banks
to engage in direct equity investment, securities underwriting and brokerage,
real estate development, and insurance underwriting and agency.4
Further, interstate banking began with the development of regional compacts at
the state level.5 At the federal level, the OCC expanded the powers
in which national banks could engage that were considered “incidental to
banking.” As a result, national banks expanded their insurance, securities and
mutual fund activities.

Then
in 1991, the Federal Deposit Insurance Corporation Improvement Act (FDICIA)
limited the investments and other activities of state banks to those
permissible for national banks and the differences between the two bank
charters again narrowed.6 In response, most states enacted
wild-card statutes that allowed their banks to engage in all activities
permitted national banks.7

Most
recently, competition between the two charters for member institutions has led
the OCC to assert its authority to preempt certain state laws that obstruct,
limit, or condition the powers and activities of national banks. As a result,
national banks have opportunities to engage in certain activities or business
practices not allowable to state banks.8 The OCC is using this
authority to ensure that national banks operating on an interstate basis are
able to do so under one set of laws and regulations—those of the home state.
In this regard, for banks operating on an interstate basis, the national bank
charter offers an advantage since states do not have comparable preemption
authority. (In theory, however, nothing prevents two or more states from
harmonizing their banking regulations and laws so that state banks operating
throughout these states would face only one set of rules.) Thus, the OCC’s
preemption regulations reinforce the distinction between the national and
state-bank charters that characterizes the dual banking system.

Funding Bank Supervision

The
gradual lessening of the differences between the two charters has brought the
disparities in the fees banks pay for supervision into the spotlight as bank
regulators have come under increased fiscal pressure to fund their operations
and remain attractive choices. How bank supervision is ultimately funded will
have implications for the viability of the dual banking system. It has always
been the case that most state bank regulators and the OCC are funded primarily
by the institutions they supervise,9 but it used to be that
differences in the fees paid by banks for regulatory supervision were secondary
to the attributes of their charters. Now, however, the growing similarity of
attributes has made the cost of supervision more important in the regulatory
competition between states and the OCC to attract and retain member
institutions. This competition has tempered regulators’ willingness to
increase assessments and has left them searching for alternative sources of
funding that will not induce banks to switch charters. The question for state
bank regulators and the OCC, then, is how to fund their operations while
remaining attractive charter choices in an era of fewer but larger banks. Here
we summarize the funding mechanisms currently in place, and in a later section
we discuss alternative means for funding bank supervision.

The OCC’s Funding Mechanism

In
the mid-1990s, after charter changes by a number of national banks,10
the OCC began a concerted effort to reduce the cost of supervision, especially
for the largest banks. The agency instituted a series of reductions in
assessment fees and suspended an adjustment in its assessment schedule for
inflation.11 When the inflation adjustment was reinstated in 2001,
it was applied only to the first $20 billion of a bank’s assets. In 2002, the
OCC revised its general assessment schedule and set a minimum assessment for
the smallest banks. These changes reduced the cost of supervision for many
larger banks, while increasing the cost for smaller banks—thus, making the
assessment schedule even more regressive than previously. For example,
national banks with assets of $2 million or less faced an assessment increase
of at least 64 percent, while larger banks experienced smaller percentage
increases or actual reductions in assessments.

The
OCC charges national banks a semiannual fee on the basis of asset size, with
some variation for other factors (see below). The semiannual fee is determined
by the OCC’s general assessment schedule. As table 1 and figure 1 show, the
marginal or effective assessment rate declines as the asset size of the bank
increases.

The
marginal rates of the general assessment schedule are indexed for recent
inflation, and a surcharge—designed to be revenue neutral—is placed on banks
that require increased supervisory resources, ensuring that well-managed banks
do not subsidize the higher costs of supervising less-healthy institutions.
The surcharge applies to national banks and federal branches and agencies of
foreign banks that are rated 3, 4, or 5 under either the CAMELS or the ROCA
rating system.12 For banking organizations with multiple national
bank charters, the assessments charged to their non-lead national banks are
reduced.13 In 2004, these general assessments provided
approximately 99 percent of the agency’s funding.14 The remaining 1
percent was provided by interest earned on the agency’s investments and by
licensing and other fees. As indicated in note 9, the OCC does not receive any
appropriated funds from Congress.

The States’ Funding Mechanisms

The
assessment structures used by the states to fund bank supervision vary
considerably, although some features are common to most of them. Most states
charge assessments against some measure of bank assets, and in many the
assessment schedule is regressive, using a declining marginal rate. (See the
appendix for several representative examples of state assessment schedules.)
More than half of all states also impose an additional hourly examination fee.
Only a few states link their assessments to bank risk—for example, by factoring
CAMELS ratings into the assessment schedule.15

To
illustrate the differences in the supervisory assessment fees charged by the
OCC and the states, we calculated approximate supervisory assessments for two
hypothetical banks, one with $700 million in assets and one with $3.5 billion.
We used assessment schedules for the OCC and four states—Arizona,
Massachusetts, North Carolina, and South Dakota—whose assessment structures are
representative of the different types of assessment schedules used by the
states. Like the OCC, Arizona and North Carolina use a regressive assessment
schedule and charge assessments against total bank assets; however, neither
makes any adjustment based on bank risk. Arizona’s assessment schedule makes
finer gradations at lower levels of asset size than does North Carolina’s
schedule. Massachusetts uses a risk-based assessment schedule in which
assessments are based on asset size and CAMELS rating. Banks are grouped as
CAMELS 1 and 2, CAMELS 3, and CAMELS 4 and 5. Within each CAMELS group there
is a regressive assessment schedule so that banks are charged an assessment
based on total bank assets. South Dakota charges a flat-rate assessment
against total bank assets.

The
results are shown in table 2. As expected, the assessments for supervision
paid by state-chartered banks are significantly less than those paid by
comparably sized OCC-supervised banks. As noted above, a likely cause of this
disparity is that the states share their supervisory responsibilities with
federal regulatory agencies (that is, with the FDIC and the Federal Reserve) that
do not charge for their supervisory examinations of state-chartered banks.

The
Effect on Regulatory Competition of Changes in the Banking Industry

Cost
competition between state regulators and the OCC, and among state regulators
themselves, has been fueled by two important structural changes that have
occurred in the banking industry over the past two decades. The number of bank
charters has declined, largely because of increased bank merger and
consolidation activity, and the size and complexity of banking organizations
has increased.

The
first change—a decline in the number of charters—means that the OCC and state
regulators are competing for a declining member base. As we have seen, the
cost of supervision remains one of the few distinguishing features of charter
type. In ways that we explain below, the declining member base puts an additional
constraint on the regulators’ ability to raise assessment rates, even in the
face of rising costs to themselves.

The
second important structural change of the past two decades—the increasing
complexity of institutions—also complicates the funding issue, for it may
impose added supervisory costs that are not reflected in the current assessment
schedules. As explained in the previous section, the OCC and most states
currently charge examination fees on the basis of an institution’s assets, but
for a growing number of institutions, that assessment base does not reflect the
operations of the bank.

The Net Decline in the Number of
Bank Charters

The
net decline in the number of banking charters since 1984 has resulted from two
main factors. One is the lifting of legal restrictions on the geographic
expansion of banking organizations—a lifting that provided incentive and
opportunity for increased mergers and consolidation in the banking industry—and
the other is the wave of bank failures that occurred during the banking crisis
of the late 1980s and early 1990s.16

Until
the early 1980s, banking was largely a local business, reflecting the limits
placed by the states on intra- and interstate branching. At year-end 1977, 20
states allowed statewide branching, and the remaining 30 states placed limits
on intrastate branching.17 However, as the benefits of geographic
diversification became better understood, many states began to lift the legal
constraints on branching. By mid-1986, 26 states allowed statewide branch
banking, while only 9 restricted banks to a unit banking business. By 2002,
only 4 states placed any limits on branching.18 Interstate banking,
which was just beginning in the early 1980s, generally required separately
capitalized banks to be established within a holding company structure.
Interstate branching was virtually nonexistent.19

The
passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 imposed a consistent set of standards for interstate banking and branching
on a nationwide basis.20 With the widespread lifting of the legal
constraints on geographic expansion that followed, bank holding companies began
to consolidate their operations into fewer banks. Bank acquisition activity
also accelerated.

Bank
failures took a toll on the banking industry as well, reaching a peak that had
not been seen since the Great Depression: from 1984 through 1993, 1,380 banks
failed.21 Mergers and acquisitions, however, remained the single
largest contributor to the net decline in banking charters. Overall, the
number of banks declined dramatically from 1984 through 2004, falling from
14,482 to 7,630. At the same time, the average asset size of banks increased.
(See table 3.)

The
rise in interstate banking, in particular, fueled competition both among state
regulators and between state regulators and the OCC. Mergers of banks with
different state charters caused the amount of bank assets supervised by some
state regulators to decline, and the amount supervised by other state regulators
to increase commensurately.22 Similarly, mergers between
state-chartered and national banks caused assessment revenues and supervisory
burden to shift between state regulators and the OCC. While the number of
banks was thus declining, the average asset size of the banks was increasing.
Because of the regressive nature of most assessment schedules, this resulted in
a decline of assessment revenues per dollar of assets supervised. For bank
holding companies, this provided an incentive to merge their disparate banking
charters. For supervisors, mergers have proved more problematic. In general,
the regressive nature of most assessment schedules suggests that regulators
enjoy economies of scale in supervision. However, given the increased complexity
of many large banks (discussed below), the existence of such economies is
questionable.23

A
hypothetical example (taken from table 2) further highlights the effects of
consolidation and merger activity on the regulatory agencies. All else equal
(that is, holding constant the assessment schedules shown in table 2), changes
in the structure of the industry over time have reduced the funding available
to the supervisory agencies. Consider a bank holding company with five
national banks, each with an average asset size of $700 million. The lead bank
would pay an annual assessment to the OCC of $159,000, and each of the
remaining banks would be assessed $139,920.24 The total for the
five banks would be $718,680. But if these banks were to merge into one
national bank with $3.5 billion in assets, the assessment owed the OCC would
decline to $569,000—a saving to the bank of $149,680 in assessment fees for
2002. Similar results can be derived for each of the states in the table
except South Dakota, which has a flat-rate assessment schedule.

The Growth of Complex Banks

During
the 1990s, we have seen the emergence of what are termed large, complex banking
organizations (LCBOs) and the growth of megabanks owned by these organizations.25
In 1992, 90 banks controlled one-half of industry assets; by the end of the
decade, the number of banks that controlled one-half of industry assets had
shrunk to 26, and at year-end 2004 to 13.26 These large banks
engage in substantial off-balance-sheet activities and hold substantial
off-balance-sheet assets. As a result, existing assessment schedules based
solely on asset size have become less-accurate gauges of the amount of
supervisory resources needed to examine and monitor them effectively.

Because
of their size, geographic span, business mix (including nontraditional
activities), and ability to rapidly change their risk profile, megabanks
require substantial supervisory oversight and therefore impose extensive new
demands on bank regulators’resources. In response, supervisors have created a
continuous-time approach to LCBO supervision with dedicated on-site
examiners—an approach that is substantially more resource-intensive than the
traditional discrete approach of annual examinations used for most banks.

For
example, the OCC—through its dedicated examiner program—assigns a full-time
team of examiners to each of the largest national banks (at year-end 2004, the
25 largest). In size, these teams of examiners range from just a few to 50,
depending on the bank’s asset size and complexity. The teams are supplemented
with specialists—such as derivatives experts and economists—who assist in
targeted examinations of these institutions.27

Like
the trend toward greater consolidation of the industry, the trend toward
greater complexity leads us to question the adequacy of the funding mechanism
for bank supervision. The need for additional resources to supervise
increasingly large and complex institutions, combined with the regulators’
limited ability to raise assessment rates given their concerns with cost
competition, creates a potentially unstable environment for banking
supervision. If regulatory competition on the basis of cost should yield
insufficient funding, the quality of the examination process might suffer. To
ensure the adequacy of the supervisory process, the potential for a funding
problem must be addressed. In addressing this issue, however, the possibility
for other unintended consequences must not be overlooked. In particular,
solutions to the funding problem could bring into question the long-term
survivability of the dual banking system. In the next section we look at a
lesson from the thrift industry to illustrate this problem.

Funding Supervision: Lessons from the Thrift Industry

The
history of the thrift industry shows how the choice of charter type can be
influenced by changes in the tradeoff between the powers conferred by
particular charters and the cost of bank supervision, and what that implies for
the viability of the dual banking system. Like the commercial banking
industry, the thrift industry also operates under a dual chartering system.
States offer a savings and loan association (S&L) charter; some states also
offer a savings bank charter. At the federal level, the Office of Thrift Supervision
(OTS) offers both a federal S&L charter and a federal savings bank (FSB)
charter.28 All state-chartered thrifts are regulated and supervised
by their state chartering authority and also by a
federal agency—the OTS in the case of state-chartered S&Ls, and the FDIC in
the case of state-chartered savings banks.29

The Thrift Industry to 1989

Before
the 1980s, S&Ls and savings banks operated under limited powers, largely
because they served particular functions: facilitating home ownership and
promoting savings, respectively.30 In 1979, changes in monetary
policy resulted in steep increases in interest rates, which in turn caused many
S&Ls to face insolvency. The books of a typical S&L reflected a
maturity mismatch—long-term assets (fixed-rate mortgage loans) funded by
short-term liabilities (time and savings deposits). When interest rates
spiked, these institutions faced the prospect of disintermediation: depositors
moving their short-term savings deposits out of S&Ls and into
higher-earning assets. In response, many S&Ls raised the rates on their
short-term deposits above the rates they received on their long-term
liabilities. The resultant drain on their capital, coupled with rising
defaults on their loans, caused some institutions to become insolvent.

In
1980 and again in 1982, Congress enacted legislation intended to resolve the
unfolding S&L crisis, turning its attention to interest-rate deregulation
and other regulatory changes designed to aid the suffering industry.31
For federally chartered thrifts, the requirements for net worth were lowered,
ownership restrictions were liberalized, and powers were expanded. The Federal
Home Loan Bank Board (FHLBB) subsequently extended many of these relaxed
requirements to state-chartered S&Ls by regulatory action.32
Congress also raised the coverage limit for federal deposit insurance from
$40,000 to $100,000 per depositor per institution, and lifted interest-rate
ceilings. In turn, many states passed legislation that provided similar
deregulation for their thrifts.33

Despite
efforts to contain the thrift crisis throughout the 1980s, the failure rate for
S&Ls reached unprecedented levels. Between 1984 and 1990, 721 S&Ls
failed—about one-fifth of the industry. At the end of the decade, with passage
of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRREA), Congress and the administration finally found a resolution to the
crisis. FIRREA authorized the use of taxpayer funds to resolve failed thrift
institutions, and it significantly restructured the regulation of thrifts.34
Federal regulation and supervision of all S&Ls (both state- and federally
chartered) and of federally chartered savings banks were removed from the FHLBS
and placed under the newly created OTS.35 Federal regulation and
supervision of state-chartered savings banks remained with the FDIC.

FIRREA
also imposed standards on thrifts that were at least as stringent as those for
national banks. Such standards covered capital requirements, limits on loans
to one borrower, and transactions with affiliates. Moreover, FIRREA placed
limits on the activities of state-chartered thrifts, with the result that
differences in the powers of state- and federally chartered thrift institutions
largely disappeared.

The Demise of the State-Chartered S&L

FIRREA’s
replacement of the FHLBS with the OTS as the regulator of state-chartered
S&Ls at the federal level and the restrictions placed on those
institutions’ powers were especially important in terms of the subject of this
article. Like the OCC—but unlike the FHLBS—the OTS does not have an internally
generated source of funding for its supervisory activities.36 The
OTS funds itself by charging the institutions it supervises for their
examinations.37 As a result, since 1990 state-chartered S&Ls
have faced a double supervisory assessment: they have been assessed both by
their state chartering authority and, at the federal level, by the OTS. In
contrast, a second set of thrifts—state-chartered savings banks (regulated by
the FDIC at the federal level)—continue to pay supervisory assessments only to
their state chartering authority. (As noted above, the FDIC does not charge
for supervisory exams.) And a third set of thrifts—federally chartered thrifts
(both S&Ls and FSBs)—are assessed only by the OTS.

Figure 2 demonstrates that between 1984 and 2004, the number of state-chartered
savings institutions declined relative to the number of federally chartered
institutions. In 1984, the industry was almost evenly split between the two
chartering authorities, but by 2004, only 42 percent of the industry was state
chartered. Further, the percentage of all savings institutions whose regulator
at the federal level was the OTS or its predecessor (the FHLBS) also declined
significantly—dropping from 92 percent in 1984 to 66 percent in 2004.

The
trends in the composition of the savings industry are further depicted in
figure 3 and 4. Figure 3 illustrates trends in charter type and federal
regulator for all savings institutions for selected years from 1984 and 2004,
and figure 4 depicts trends in the federal regulation specifically of
state-chartered savings institutions.38

The
shift in the composition of federally regulated state-chartered institutions is
most noticeable between 1989 and 1994—the period since the inception of the
OTS. During this period, the number of state-chartered/OTS-regulated S&Ls
declined by approximately two-thirds, whereas the number of federally
chartered/OTS-regulated savings institutions declined by only one quarter. At
the same time, the number of state-chartered/ FDIC-regulated savings banks grew
by almost 30 percent. Since 1994, the number of state-chartered/OTS-regulated
S&Ls has declined at almost double the rate of federally chartered/OTS-regulated
savings institutions. In fact, state-chartered/OTS-regulated S&Ls have
almost disappeared. At year-end 2004, only 104 such institutions remained—a
decrease of 93 percent since 1984.

Figure 4, focusing on the trends for state-chartered savings institutions alone,
juxtaposes the growth in the number of state-chartered savings institutions
regulated by the FDIC against the declining numbers of state-chartered savings
institutions regulated by the OTS.

Analysis of the Demise

The
demise of the state-chartered/OTS-regulated S&L was probably inevitable
after the special powers enjoyed by these institutions were eliminated, as
their cost of supervision was higher than that of federally chartered
S&Ls. In fact, the federal charter might have displaced the state charter
to an even greater extent than that noted above if not for two important
changes. First, numerous states began to offer a savings bank charter in the
early 1990s. Second, FIRREA allowed all S&Ls to change their charter to
either a savings bank or a commercial bank charter. (Institutions that changed
their charter were required to remain insured by the Savings Association
Insurance Fund [SAIF] and were designated as Sasser banks.)39 For
S&Ls chartered in states that offered a savings bank charter, converting to
that charter became a way to eliminate OTS supervision and the accompanying
fees. In contrast to the demise of the state-chartered S&L, the population
of state-chartered/FDIC-regulated savings banks increased substantially during
the same period. Although their powers were also constrained by FIRREA, these
institutions avoided supervisory costs at the federal level.

Between
1989 and year-end 2004, 350 savings institutions took advantage of the Sasser
option to become state-chartered savings banks, regulated by the FDIC but
insured by the SAIF. Figure 5 depicts this increase. One reason for these
charter changes could have been a desire to escape the reputational effects of
being known as an S&L after the bankruptcy of the Federal Savings and Loan
Insurance Corporation. However, in the years following that bankruptcy, many
S&Ls were able to change their name—and leave behind the reputational
problems associated with the term S&L—without having to change their
charter. A more likely cause of the growth in Sasser banks was the elimination
of special powers enjoyed by state-chartered institutions coupled with the
extra assessment cost that they could no longer justify.

Evidence
on de novo thrifts also supports the belief that the double assessment coupled
with the elimination of special powers played a role in the demise of
state-chartered S&Ls. An analysis of the thrifts chartered after the
passage of FIRREA shows that the majority were OTS charters (see figure 6).
From 1989 through 2004, 34 institutions were chartered at the state level, and
33 of them chose to become FDIC-regulated savings banks; only one chose to
become an OTS-regulated S&L.40 By contrast, 147 institutions
received OTS charters. Thus, 99.4 percent of thrifts chartered from 1989 to
2004 chose a charter that allowed them to avoid paying a double assessment.

These
aggregate data have showed the importance of maintaining balance in the
trade-off between powers and the cost of supervision in charter choice. The
experiences of individual states show something more: the consequences for a
dual chartering system when that balance disappears so that one charter becomes
clearly favored over the other and there is no alternative. In California, for
example, the imposition of a double assessment on state-chartered institutions
and the absence of a state-chartered savings bank alternative have contributed
to the demise of the state charter for thrifts. In 1984, 73 percent of
California thrifts were state chartered; in 2004, there were no state-chartered
thrifts. Conversely, the experience in Illinois illustrates that when there is
an alternative, the state charter can remain a viable choice. In 1984, 44
percent of Illinois thrifts were state chartered, although no state savings
bank charter was available. Following the enactment of FIRREA, Illinois
created a state savings bank charter and institutions began to convert to
Sasser banks. By 2004, the percentage of state-chartered thrifts had increased
to 52 percent, with state-chartered savings banks dominating the mix—accounting
for 88 percent of state-chartered thrifts.

Charter Choice—Maintaining an Attractive Charter

The
narrowing of differences in state and national bank charters has both simplified
the process of choosing a bank charter and focused greater attention on how to
remain a viable charter choice. For bankers, charter choice is now generally a
question of whether the higher assessment cost associated with a national
charter is offset by the benefits of operating under a single set of laws and
regulations—the OCC’s preemption authority. For bank regulators, charter
choice entails working to contain the cost of supervision and finding
alternative ways to make charters attractive.

For
the public, the competition between federal and state bank regulators to offer
an attractive charter and the choices that banks ultimately make will affect
them in a number of ways. Concerns will be raised about the dual banking
system’s ability to generate adequate funding (and therefore whether there is
an effective level of prudential supervision, especially in an era of larger
and more complex banks). Concerns will also be raised about how consumer
protection and other laws affected by preemption are applied and enforced.
Ultimately, concerns will be raised about the long-term viability of the dual
banking structure and whether such a system is still relevant.41

Switching Charters—A State Responds

The
recent experience of New York shows the effects of the decision to switch
charters on the chartering authorities. In July 2004, J. P. Morgan Chase &
Co. and Bank One Corporation merged. The result was a combined company that
had over one trillion dollars in assets, five banking charters (four national
and one state), and operations in all 50 states. In November 2004, the charter
of the lead bank, J. P. Morgan Chase Bank ($967 billion in assets), was
converted to a national bank charter. As a result, the State of New York
Banking Department (NYBD) lost significant revenue from supervisory
assessments. In addition, HSBC Holding PLC had converted the New York charter
of its lead bank, HSBC Bank USA ($99 billion in assets), to a national charter
in July 2004. Together, the assessment revenue from J. P. Morgan Chase Bank
and HSBC Bank USA had accounted for approximately 30 percent of the NYBD’s
operating budget.42

Before
the loss of these two banks, the NYBD had already been working to change its
funding mechanism. An NYBD study had found that state-chartered banks, which
represented 10 percent of their state-licensed institutions, were carrying the
department’s entire budget.43 The NYBD found it necessary to revise
its assessment schedule and expand its assessment base. Effective with the
2005 fiscal year, the assessment base was revised to include all licensed and
regulated financial institutions. For the first time, financial institutions
other than banks paid annual fees for supervision in addition to any exam and
licensing fees. The NYBD is also considering revising its charter to make it
more attractive to banks and thrifts. In an attempt to modernize, the NYBD
proposed the adoption of a wild-card statute that would convey federal bank
powers to banks chartered in New York.44

Switching Charters—The OCC Responds

Although
J. P. Morgan Chase Bank and HSBC Bank USA indicated their preference for a
national charter, the OCC did not fare as well in the mid-1990s. For example,
when The Chase Manhattan Bank N. A. completed its merger with Chemical Bank in 1995,
it chose to retain Chemical’s New York state charter. The loss of this large
bank followed the loss of 28 banks under its charter in 1994. Beginning in
1995, the OCC instituted a series of reductions in assessment fees and
suspended the inflation adjustment factor in its 1995 assessment schedule. It
continued to lower total assessments in 1996, and then in 1997, the OCC
implemented a restructured assessment schedule to more accurately differentiate
among banks and the resources they were likely to require in an examination.
The number of national banks that switched charters declined after 1994,
remaining at about 10 per year, until 2001 when the number again jumped.45

The
conversion of J. P. Morgan Chase Bank to a national charter cited above also
poses issues for the OCC. The charter switch brought additional assets under
the OCC’s supervision, and subsequently increased the agency’s supervisory
burden. The OCC indicated that additional supervisory resources would be
focused on the risks posed by and across business lines. It planned to hire
additional examiners and to increase its specialized supervisory skills in
areas such as derivatives and mortgage banking—areas in which J. P. Morgan
Chase Bank is highly active.46 Revenues from the assessments paid
by the bank will offset these increases in supervisory costs. However, whether
the revenues will be enough is problematic as a one-to-one relationship does
not necessarily exist between costs and revenues in the assessment schedule.

Approaches
to Funding Bank Supervision

Following
the increase in the number of banks switching charters in 2001, then
Comptroller of the Currency, John D. Hawke Jr., began a series of speeches
calling for reform of the bank supervisory funding system. Arguing that the
viability of the dual banking system should not rest on the maintenance of a
federal subsidy for state-chartered banks, he proposed that a new approach to
the funding of bank supervision be found.47 That new approach
should “strengthen both the federal and state supervisory processes, protect
them from the impact of random structural changes, and ensure that all
supervisors, state and national, have adequate, predictable resources available
to carry out effective supervisory programs.”48

Passing the Cost through the Deposit Insurance Funds

Specifically,
Hawke argued that if the costs of bank supervision were passed through the
deposit insurance funds (for example, if the interest earned on the deposit
insurance funds were used to pay for all bank supervision), the subsidy
provided to state-chartered banks at the expense of national banks could be
eliminated and at the same time an adequate source of funding for bank
supervision could be ensured.49 For this result to be achieved, all
costs for bank supervision (costs of the states and the OCC) or some or all of
the OCC’s supervisory costs would have to be covered. In either case, the
federal subsidy (that is, the national-bank subsidy) to state-chartered banks
for the cost of bank supervision would be eliminated. The effect on the dual
banking system is less clear. Once the states and the OCC were no longer
competing for member banks on the basis of cost, the state charter might become
relatively less attractive.

To
discover the effects of funding total supervisory costs for the states and the
OCC through the deposit insurance funds, we performed a sensitivity analysis of
four large banks—two regulated by the OCC and two by the states—and an average
community bank. The immediate effects would be twofold. First, the operating
expenses of the FDIC would increase, which in turn would cause the reserve
ratio—the ratio of the deposit insurance fund balance to estimated insured
deposits—to be lower than it otherwise would be. Second, the assessment base for
supervisory costs would be changed from assets to domestic deposits because
deposit insurance premiums are assessed against domestic deposits. The
incidence of the supervisory assessment would shift, falling more heavily on
institutions funded primarily by domestic deposits. In other words, relying on
the deposit insurance funds to cover the cost of bank supervision would change
the basis on which supervision is paid and would therefore alter the allocation
of cost among banks.

First
we calculated the asset-based fee paid by these banks for supervision in 2002
(the latest date for which state assessment data were available). For the
average community bank, we calculated this cost for three chartering
authorities—the OCC, Georgia, and North Carolina. For 2002, the supervisory
costs of the states and the OCC totaled approximately $698 million.50

If
the FDIC had paid the cost of supervision for the OCC and the states through
the deposit insurance funds, the five banks would have borne the cost on the
basis of their domestic deposits rather than assets. To understand the effect
that changing the assessment base could have on individual banks, we assumed
that the total cost of supervision ($698 million) would be passed on to the
banks. Under this scenario, a flat-rate premium assessment of 1.9 basis points
(bp)—or about 2/100ths of a percent—of domestic deposits would be required.51

As
table 4 shows, the incidence of the supervisory assessment shifts toward banks
that have relatively high domestic deposit-to-asset ratios. Bank of America
would have owed approximately $23 million more in assessments. By contrast,
Citibank would have owed approximately $14 million less. For the average
community bank, the difference would depend on its charter. If the bank were
chartered in Georgia, its assessment would have declined by approximately
$3,000, but in North Carolina, its assessment would have risen by approximately
$5,000.

Although
this approach would eliminate one inequity—the subsidization of state-chartered
banks by nationally chartered banks—it would likely create others. First,
assessment fees (and supervisory costs) vary considerably from state to state,
and as a result, states with relatively high supervisory costs would benefit at
the expense of states with lower supervisory costs. Second, funding
supervision through the insurance funds would remove the incentives for the
states and the OCC to keep their supervisory costs low. Third, the deposit
insurance funds were designed for other purposes and therefore passing all
supervisory costs through the funds would obscure the purpose of the funds.

Other Approaches to Funding Bank Supervision

Although
Hawke’s approach focuses on funding bank supervision through the use of the
deposit insurance funds, other approaches exist. One suggestion would be to
fund bank supervision through the Federal Reserve, another would be to
alternate examinations between the OCC and the other federal regulators, and a
third approach would be to develop an assessment schedule for bank examination
at the federal level. These approaches are briefly discussed below.

One
alternative approach is to fund bank supervision through the Federal Reserve.
Banks do not earn any interest on funds they hold in reserve accounts at the
Federal Reserve, and policy makers (including the Federal Reserve itself) have
long advocated that interest be paid on required reserve balances—sterile
reserves. In this suggestion, in lieu of paying interest on sterile reserve
balances, the Federal Reserve could dedicate that implicit interest to cover
supervisory costs for all banks. All banks are required to hold the same
percentage of reserves on their deposits, so the incidence of this proposal
would be neither progressive nor regressive, although banks that were
especially reliant on deposits would be hit the hardest. In effect, a portion
of the surplus that the Federal Reserve currently transfers to the U.S.
Treasury would be diverted to cover the costs of bank supervision. For the
same reasons as enumerated above, this proposal would likely eliminate one
inequity but create others.

Another
alternative is for the OCC and other federal bank regulators to rotate
examination of nationally chartered banks, as is done with state-chartered
banks. If this were done, state and national banks would be treated
comparably, and the shared examination function would give the FDIC a better
understanding of its risk exposure to national banks. A disadvantage, however,
is that requiring multiple federal regulators to maintain the resources
necessary to examine the same set of national banks would introduce
inefficiencies to the supervisory process. And where the OCC uses a resident
examination staff (as it currently does in 25 national banks), alternating
exams with the FDIC (or the Federal Reserve) might be problematic. A second
disadvantage is that the proposal does not resolve the cost competition between
the OCC and the state bank chartering authorities.

The
last approach we discuss is for the FDIC and the Federal Reserve to assess
state-chartered banks directly for the cost of their supervision. To do this,
the FDIC and the Federal Reserve would have to unbundle the cost of supervision
from the cost of their other activities. In the case of the FDIC, the assessment
it imposes on financial institutions could be broken into a deposit insurance
component and a supervisory component. The deposit insurance component would
be charged to all FDIC-insured institutions, and the supervisory component
would be charged to institutions for which the FDIC is the primary federal
regulator.52 Similarly, the Federal Reserve could charge
state-chartered member banks for their cost of supervision. To implement this
proposal, the federal regulators could develop separate assessment schedules
for each of their agencies, or they could work together to establish a single,
uniform assessment schedule.

Proponents
argue that the imposition of federal fees would end the federal subsidy of
state-chartered banks. Opponents argue that the proposal would damage the dual
banking system by eliminating one of its few remaining differences. Proposals
to impose federal fees on state-chartered banks for their federal supervision
have often been included in the annual federal budget process but Congress has
routinely rejected them.

Conclusion

As
the powers of state-chartered and national banks have converged, the number of
reasons for a bank to choose either a state or a federal charter has declined.
One of the few remaining differences between the charters is cost. In the
competition between regulators for institutions, therefore, the cost of
supervision has assumed greater importance, and in this area, state-chartered
banks have the advantage. State-chartered banks generally pay lower exam fees,
at least partly, because the federal agencies—FDIC or Federal Reserve—alternate
examinations with the states and these federal agencies do not charge for
exams. The OCC, and national banks, in contrast, must cover the full costs of
bank examinations.

The
thrift experience demonstrates how the choice of charter type can be influenced
by changes in the balance between powers and the cost of supervision. When
differences in the powers of state- and federally chartered savings and loans
disappeared, the proportion of S&Ls with state charters changed
dramatically. Many converted from an S&L charter to a savings bank
charter. In states where this was not an option, the number of state-chartered
S&Ls declined dramatically, almost disappearing.

Currently
the higher supervisory assessments for national banks are offset by the
preemption benefits that they enjoy. Conversely, state-chartered banks do not
receive the benefits of preemption, but their supervisory costs are lower. As
the situation is developing, the OCC is becoming the regulator of large,
complex banks—banks that are likely to have an interstate presence and benefit
from preemption. Smaller, more traditional banks continue to find the state
charter attractive. Although both charters remain viable, a bifurcation within
the dual banking system appears to be developing.53 If either of
these components is materially changed, then banks—like state-chartered
S&Ls —may be induced to switch charters. The result may be to undermine
the dual banking system.

Before any modification is made to the structure for
funding bank supervision, a public-policy debate should be undertaken.
Supervisors need a funding mechanism that reflects not only the costs they
incur to supervise banks but also proves to be a stable source of funding in
the long term. To this end, a number of proposals have addressed this issue.
Each may provide a solution to the funding problem. However, given the few
differences that remain between the bank charters, any change in the funding
mechanism will affect the viability of the dual banking system. If the dual
structure of the banking system still serves a purpose, then its disappearance
should not be an unintended consequence.

Board of Governors of the Federal Reserve System,
Federal Deposit Insurance Corporation, Office of the Comptroller of the
Currency, and Office of Thrift Supervision. 2005. Press Release: Interagency
Advisory on the Confidentiality of the Supervisory Rating and Other Nonpublic
Supervisory Information. February 28. FDIC. http://www.fdic.gov/news/news/press/2005/pr1805a.html.

Conference of State Bank Supervisors (CSBS). 1977. A
Profile of State-Chartered Banking. CSBS.

———. 2002. A Profile of State-Chartered Banking.
CSBS.

Federal Deposit Insurance Corporation (FDIC). 1997. History
of the Eighties: Lessons for the Future. Vol. 1, An Examination of the
Banking Crises of the 1980s and Early 1990s. FDIC.

———. 2002a. Annual Report. FDIC.

———. 2002b. Quarterly Banking Profile. Second
Quarter. FDIC.

Federal Home Loan Bank Board (FHLBB). 1983. Agenda
for Reform, A Report on Deposit Insurance to the Congress from the Federal Home
Loan Bank Board. FHLBB.

Hammond, Bray. 1957. Banks and Politics in America:
From the Revolution to the Civil War. Princeton University Press.

State of New York Banking Department (NYBD). 2005.
Superintendent Taylor’s Remarks to the New York Bankers Association: Revenue
Restructuring and Future Plans, January 10. http://www.banking.state.ny.us/sp050110.htm
[April 11, 2005].

Examination fees and supervisory assessments are set
by the commissioner and by statute. The commissioner determines how collected
funds are allocated, appropriated, and spent. Assessments are levied annually.

Additional hourly fees: $60 per hour per examiner for
trust exams.

Fee-sharing agreements: Permitted by the state; the
Arizona State Banking Department has fee-sharing agreements with Alabama and
North Dakota.

Agreements to share examiner resources: The state of
Arizona permits such agreements. The Arizona State Banking Department
currently has none in place.

Statute authorized the Executive Office of
Administration and Finance to set examination fees and supervisory
assessments. The Massachusetts Division of Banking has wide discretion over
how collected funds are allocated, appropriated, and spent.

Additional hourly fees: A per diem fee of $220 per
examiner for nonbank licenses.

Fee-sharing agreements: Permitted by the state; the
Massachusetts Division of Banking has none in place.

Agreements to share examiner resources: Permitted by
the state; the Massachusetts Division of Banking has none in place.

The North Carolina Commissioner of Banks operates
under guidelines set by the Department of Commerce and by state policies.
Examination fees and supervisory assessments are set by statute. Any discounts
or premiums from the statutory rate must be approved by the Commission. The
Commissioner of Banks also determines how collected funds are allocated,
appropriated, and spent.

Examination fees and supervisory assessments are set
by the Banking Board and by statute. The Division of Banking’s total budget is
appropriated by the South Dakota legislature. Expenditures are approved by the
Director of Banking. Assessments are levied semiannually.

Additional hourly fees: None.

Fee-sharing agreements: Permitted by the state;
agreements are in place with Minnesota and North Dakota.

Agreements to share examiner resources: Permitted by
the state; agreements are in place with Minnesota and North Dakota.

Rebate authority: None.

Source: CSBS (2002).

FOOTNOTES

* The authors are senior financial economists in the Division of Insurance and Research at the Federal Deposit Insurance Corporation. This article reflects the views of the authors and not necessarily those of the Federal Deposit Insurance Corporation. The authors thank Sarah Kroeger and Allison Mulcahy for research assistance; Grace Kim for comments on an earlier draft; and Jack Reidhill, James Marino, and Robert DeYoung for comments and guidance in developing the paper. Any errors are those of the authors. Comments from readers are welcome.

1 In addition, the Federal Reserve supervises the holding companies of commercial banks, and the FDIC has backup supervisory authority over all insured depository institutions.

2 The new currency--U.S. bank notes, which had to be backed by Treasury securities--would trade at par in all U.S. markets. The new currency thus created demand for U.S. Treasuries and helped to fund the Civil War. At the time, it was widely believed that a system of national banks based on a national currency would supplant the system of state-chartered banks. Indeed, many state-chartered banks converted to a national charter after Congress placed a tax on their circulating notes in 1865. However, innovation on the part of state banks--the development of demand deposits to replace bank notes--halted their demise. See Hammond (1957), 718-34.

3 While most states subsequently required their banks to become federally insured, some states continued to charter banks without this requirement. Banks without federal deposit insurance continued to be supervised exclusively at the state level. After the savings and loan crises in Maryland and Ohio in the mid-1980s, when state-sponsored deposit insurance systems collapsed, federal deposit insurance became a requirement for all state-chartered banks.

4 For a comparison of state banking powers beyond those considered traditional, see Saulsbury (1987).

5 Beginning in the late 1970s and early 1980s, the states began permitting bank holding companies to own banks in two or more states. State laws governing multistate bank holding companies varied: some states acted individually, others required reciprocity with another state, and still others participated in reciprocal agreements or compacts that limited permissible out-of-state entrants to those from neighboring states. In 1994, Congress passed the Riegle-Neal Interstate Banking and Branching Efficiency Act, which removed most of the remaining state barriers to bank holding company expansion and authorized interstate branching. See Holland et al. (1996).

6 As amended by FDICIA, Section 24 of the Federal Deposit Insurance Act (12 U.S.C. 1831a) makes it unlawful, subject to certain exceptions, for an insured state bank to engage directly or indirectly through a subsidiary as principal in any activity not permissible for a national bank unless the FDIC determines that the activity will not pose a significant risk to the funds and the bank is in compliance with applicable capital standards. For example, the FDIC has approved the establishment of limited-liability bank subsidiaries to engage in real estate or insurance activities.

7 For a discussion of the legislative and regulatory changes affecting banks during the 1980s and early 1990s, see FDIC (1997), 88-135.

8 On January 7, 2004, the OCC issued two final regulations to clarify aspects of the national bank charter. The purpose cited was to enhance the ability of national banks to plan their activities with predictability and operate efficiently in today's financial marketplace. The regulations address federal preemption of state law and the exclusive right of the OCC to supervise national banks. The first regulation concerns preemption, or the extent to which the federally granted powers of national banks are exempt from state laws. State laws that concern aspects of lending and deposit taking, including laws affecting licensing, terms of credit, permissible rates of interest, disclosure, abandoned and dormant accounts, checking accounts, and funds availability, are preempted under the regulation. The regulation also identifies types of state laws from which national banks are not exempt. A second regulation concerns the exclusive powers of the OCC under the National Bank Act to supervise the banking activities of national banks. It clarifies that state officials do not have any authority to examine or regulate national banks except when another federal law has authorized them to do so. See OCC (2004b, 2004c).

9 Although the OCC is a bureau of the U.S. Treasury Department, it does not receive any appropriated funds from Congress.

10 For example, in 1994, 28 national banks chose to convert to a state bank charter; another 15 did so in 1995. See Whalen (2002).

11 The OCC's assessment regulation (12 C.F.R., Part 8) authorizes rate adjustments up to the amount of the increase in the Gross Domestic Product Implicit Price Deflator for the 12 months ending in June.

12 As part of the examination process, the supervisory agencies assign a confidential rating, called a CAMELS (Capital, Assets, Management, Earnings, Liquidity, and Sensitivity to market risk) rating, to each depository institution they regulate. The rating ranges from 1 to 5, with 1 being the best rating and 5 the worst. ROCA (Risk management, Operational controls, Compliance, and Asset quality) ratings are assigned to the U.S. branches, agencies, and commercial lending companies of foreign banking organizations and also range from 1 to 5. See Board et al. (2005).

15 Among the states that rely primarily on hourly examination fees to cover their costs are Delaware and Hawaii. States relying on a flat-rate assessment include Maine, Nebraska, and South Dakota. Those using a risk-based assessment scheme include Iowa, Massachusetts, and Michigan. Those assessing on the basis of their expected costs include Colorado, Louisiana, and Minnesota. One state, Tennessee, explicitly limits its assessments to no more than the amount charged by the OCC for a comparable national bank. For a listing of assessment schedules and fees by state, see CSBS (2002), 45-63.

17 Twelve of the 30 states permitted only unit banking, and the other 18 permitted only limited intrastate branching. See CSBS (1977), 95.

18 See CSBS (2002), 154. The four states were Iowa, Minnesota, Nebraska, and New York.

19 By the early 1980s, 35 states had enacted legislation providing for regional or national full-service interstate banking. Most regional laws were reciprocal, restricting the right of entry to banking organizations from specified states. See Saulsbury (1986), 1-17.

20 The act authorized interstate banking and branching for U.S. and foreign banks to be effective by 1997. See FDIC (1997), 126.

25 LCBOs are domestic and foreign banking organizations with particularly complex operations, dynamic risk profiles and a large volume of assets. They typically have significant on- and off-balance-sheet risk exposures, offer a broad range of products and services at the domestic and international levels, are subject to multiple supervisors in the United States and abroad, and participate extensively in large-value payment and settlement systems. See Board (1999). The lead banks within such organizations form a class of banks termed megabanks. Like their holding companies, they are complex institutions with a large volume of assets-typically $100 billion or more. See, for example, Jones and Nguyen (2005).

26 The 13 banks that held one-half of banking industry assets as of December 2004 (according to the FDIC Call Reports) were JPMorgan Chase Bank, NA; Bank of America, NA; Citibank, NA; Wachovia Bank, NA; Wells Fargo Bank, NA; Fleet National Bank; U.S. Bank, NA; HSBC USA, NA; SunTrust Bank; The Bank of New York; State Street Bank and Trust Company; Chase Manhattan Bank USA, NA; and Keybank, NA. Of these, only three were state-chartered.

27 After JPMorgan Chase converted from a state charter (New York) to a national charter (in November 2004), the OCC indicated it would increase its supervisory staff. The OCC is also emphasizing "horizontal" examinations, which use specialists to focus supervisory attention on specific business lines. See American Banker (2005).

28 Originally S&Ls were chartered to facilitate the home ownership of members by pooling members' savings and providing housing loans. Savings banks, by contrast, were founded to promote the savings of their members; the institutions' assets were restricted to high-quality bonds and, later, to blue-chip stocks, mortgages, and other collateralized lending. Over time, distinctions between S&Ls and savings banks largely disappeared. Additionally, an institution's name may no longer be indicative of its charter type.

29 Before 1990, federal savings institutions were regulated and supervised by the Federal Home Loan Bank System (FHLBS), which was comprised of 12 regional Federal Home Loan Banks and the Federal Home Loan Bank Board (FHLBB). The FHLBS was created by the Federal Home Loan Act of 1932 to be a source of liquidity and low-cost financing for S&Ls. In 1933, the Home Owners' Loan Act empowered the FHLBS to charter and to regulate federal S&Ls. Savings banks, by contrast, were solely chartered by the states until 1978, when the Financial Institutions Regulatory and Interest Rate Control Act authorized the FHLBS to offer a federal savings bank charter. In 1989, the Financial Institutions Reform, Recovery, and Enforcement Act abolished the FHLBB and transferred the chartering and regulation of the thrift industry from the FHLBS to the OTS. Additionally, the act abolished the thrift insurer, the Federal Savings and Loan Insurance Corporation, and gave the FDIC permanent authority to operate and manage the newly formed Savings Association Insurance Fund. Although the FHLBB was abolished, the Federal Home Loan Banks remained-their duties directed to providing funding (termed advances) to the thrift industry.

30 For example, thrifts were prohibited from offering demand deposits or making commercial loans--the domain of the commercial banking industry.

31 These pieces of legislation were respectively, the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St Germain Act of 1982.

36 Because the FHLBS had an internal source of funding (the Federal Savings and Loan Share Insurance Fund), it did not impose supervisory fees on either federally or state-chartered thrifts.

37 The OTS, like the OCC, bases its fees on an institution's asset size, and uses a regressive assessment schedule. Until January 1999, the OTS general assessment schedule based assessments on consolidated total assets. The assessments for troubled institutions were determined by a separate "premium" schedule. Both schedules were regressive: as asset size grew, the marginal assessment rate declined. In January 1999, the assessment system was revised and assessments were based on three components: asset size, condition, and complexity. Two schedules implemented the size component--a general schedule for all thrifts, and an alternative schedule for qualifying small savings associations. The condition component replaced the premium schedule; and the complexity component set rates for three types of activities--trust assets, loans serviced for others, and assets covered in full or in part by recourse obligations or direct credit substitutes. Rates were adjusted periodically for inflation, and other revisions were introduced. Effective July 2004, the OTS implemented a new assessment regulation that revised how thrift organizations are assessed for their supervision. Examination fees for savings and loan holding companies were replaced with a semiannual assessment schedule, and the alternative schedule for small savings institutions was eliminated. The stated goal was to better align OTS fees with the costs of supervision. See OTS (1990, 1998, and 2004).

38 In the following discussion and in the notation to figure 3, figure 4 and figure 6, we use "OTS-regulated" as a proxy for federal regulation that was conducted by the FHLBS for the years before 1990 and has been conducted by the OTS starting in1990.

41 In addition, concerns have been raised about the fairness of the current funding mechanism (especially to the extent that national banks may be said to subsidize state-chartered banks) and about the fairness of allowing national banks to disregard state laws that affect their operations.

42 See State of New York Banking Department (NYBD) (2005), hereinafter, NYBD (2005).

47 Because state-chartered banks do not pay for federal supervision whereas nationally chartered banks do, it is argued that state-chartered banks are effectively subsidized by nationally chartered banks through the assessments that the latter pay to the deposit insurance funds. See Hawke (2000, 2001) and Rhem (2004).

49 Work on this article was completed prior to passage of the Federal Deposit Insurance Reform Act of 2005, which will merge the two deposit insurance funds. A variation on the above proposal would have the FDIC rebate to national banks--or through the OCC for pass-through to national banks--an amount equal to its contribution to the cost of state-bank supervision. Although the case can be made that nationally chartered banks have subsidized the FDIC's supervision of state-chartered nonmember banks, it would be difficult to calculate the precise size of that subsidy. An accurate accounting of the share of the deposit insurance fund(s) attributable to national banks would necessarily have to account for both premiums paid into the funds and the relative expense to the funds of national bank failures.

50 The costs for the OCC represent supervisory and regulatory costs as reported for 2002. To obtain approximate supervisory and regulatory costs for the states, we computed from the OCC data an average cost per $1 million of assets and then applied that to the assets represented by state banks. See OCC (2003a).

51 In this scenario, it is assumed that supervisory costs would be funded in the same manner as shortages in the deposit insurance funds are currently handled. That is, the costs of supervision would be funded through a flat-rate assessment or surcharge that is levied against the assessable deposits--total (adjusted) domestic deposits--of each insured institution. The effect would be to replace the current regressive assessment system with a flat-rate assessment levied against domestic deposits. Modifications to this system could be made, if desired; however, in the interest of simplicity, we did not attempt to make any adjustments for bank risk or size.

52 The FDIC engages in many activities currently included in its supervisory budget that are required for both its role as deposit insurer and its role as primary federal supervisor. The complete separation of these functions might be neither possible nor practical.